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Why You Shouldn't Expect to Outperform the Market

On Monday, we discussed some of the issues with trying to act on Jim Cramer's advice. One of his points was that "when it comes to investing, picking the right stocks and knowing when to sell, are the two skills that keep investors ahead of the markets, and not struggling to keep up." Here's why the whole premise of individuals being likely to beat the market makes no sense.

Simply put, it's impossible for investors as a group to beat the market, because collectively we are the market. For one group to beat the market, they have to find a group of "victims" to exploit. Given that institutional investors control about 70 percent of the market, why should anyone believe that amateur, individual investors likely to succeed at exploiting the professionals, even before the costs of the efforts? What advantages do the individuals have? Are they smarter? Do they have more resources? Do they work harder at it?

There's simply no logic for believing that individuals will be able to persistently exploit the mistakes of institutional investors -- they have no advantages. Certainly, having access to Cramer is not an advantage.

The second mistake that investors make when listening to Cramer is what I call confusing information with wisdom (information you can use to beat the market). Consider carefully this observation from a fund manager at Wellington Management: "When you're looking at companies like Microsoft, International Business Machines, Merck, and Coca-Cola, the ability to capture incremental insight is so damn challenging because so many people are looking at those stocks and it takes so long to get through the body of knowledge."

The key word is incremental, because the market knows all the rest, rendering it worthless. It's like knowing the New England Patriots are a better football team than the Detroit Lions and thinking you can exploit that information by betting on the Patriots. You can't. The reason is the market knows this and requires you to give a large point spread to get someone to bet on the Lions. And the point spread equalizes the odds of either team winning.

The point is that if you are getting advice from Cramer on national TV or at, it's not a national secret. You can be sure that whatever information you are relying on is already built into prices, and, thus, has no value at all.

Tomorrow we discuss why the belief that by picking stocks you are taking control is just an illusion.

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